The so-called check the box regulations could profoundly impact the outbound tax planning of U.S. business conducting business offshore. The check the box regulations permits U.S. investors to incorporate business entities in foreign countries, particularly civil law countries, to create limited liability companies, in which all members would enjoy limited liability and which would be treated as a corporation under foreign limited liability and which could be treated as a partnership or disregarded entity under U.S. tax law. One consequence of the check the box regulations has been to facilitate the creation of entities, such as civil law limited companies, that are treated as separately taxable corporations under foreign law but as flow-through entities (either as partnerships or wholly owned entities that are disregarded) for U.S. tax purposes. Such dual character entities are often referred to as “hybrid entities” or, if wholly owned by a single member, as “hybrid branches.”
The availability of hybrid entities have led to their use by U.S. corporations and foreign corporations to reduce their global tax consequences by having the hybrid entity or branch (treated as a taxable corporation under foreign law) pay deductible royalties, interest, rents, and other payments to its parent entity, a U.S. corporation. Because these payments would be deductible for foreign tax purposes, they would reduce the amount of foreign tax imposed on the hybrid or branch. This reduction can be particularly helpful when the hybrid entity is operating in a high tax country by reducing or eliminating excess foreign tax credits. Hybrid entities can also be utilized in cross-border tax arbitrage situations to produce tax savings through the exploitation of the differences between U.S. and foreign tax rules on such matters as determining the source of income and deductions, classification of entities and determining the residence of entities for tax purposes.
If you have questions regarding the check the box regulations, contact the international tax attorneys at Diosdi & Liu, LLP for a consultation.